geopolitical briefing : the looming global water crisis

1

Economics and Strategy

Geopolitical Briefing

November 17, 2021

The Looming Global Water Crisis: An Update By Angelo Katsoras

Introduction In a January 2020 report titled “The world’s looming water crisis,” we argued that the world’s water reserves were being squeezed at both the demand and the supply ends of the curve. This meant that many countries would eventually be forced to raise water prices in order to moderate demand and face the reality that their water reserves were nowhere near sufficient to attain many of their long-term economic objectives. Among other things, this would force certain countries to choose between focusing more on industry or on agriculture.

In this follow-up report, we examine how recent developments strengthen our original findings There will be a particular focus on four countries—China, India, Brazil and the United States—and on two sectors—agriculture and mining.

United States: Water scarcity worsening in southwest While the United States is much better positioned than many other countries when it comes to water scarcity, it still faces serious challenges in certain regions. The American southwest, which has endured years of lighter-than-usual rain and dry winters, is the most prominent example. The situation even forced the Bureau of Reclamation to recently declare the first-ever water shortage for the Colorado River, which serves 40 million people.

It also caused many of the reservoirs in the southwest to drop to below half their holding capacities. Lake Mead, the nation’s largest reservoir, is in particularly dire straits. Its water level has fallen from 1,229 feet in 2000 to 1,069 feet today (35% capacity),1 the lowest point since it was first filled in the 1930s.

Lake Mead’s troubles also put at risk hydroelectric power used by about 1.3 million people across California, Nevada and Arizona. Although the hydraulic turbines can operate until the reservoir’s water level falls to 950 feet, the more that the water level drops, the less pressure there is to drive the turbines.

Source: “Reservoirs are drying up as consequences of the Western drought worsen,” Washington Post, July 9, 2021

1 “Severe Drought Could Threaten Power Supply in West for Years to Come,” Wall Street Journal, August 14, 2021

2



As goes California’s agriculture sector, so goes America’s food prices California’s $50-billion agricultural sector supplies two thirds of the country’s fruits and nuts and more than one third of its vegetables.2 It also accounts for about 20% of the nation’s milk supply.3 This arid region was able to develop into an agricultural powerhouse thanks to extensive irrigation. Agriculture accounts for about 80% of all the water used in California.4

In 2020, thousands of California farmers were allocated only 20% of the water they were originally supposed to receive from Lake Mead. This year, the percentage for many of them plunged to near zero. These farmers were forced to either abandon production or purchase water on the private market at approximately four times the price typically charged by the federal government.5

Not surprisingly, the Nasdaq Veles California Water Index, which represents the weighted average price of water-right transactions across five major markets in California, has risen significantly. The unit of measure represents the dollar amount of water needed to cover one acre of land in one foot of water, the equivalent of about 325,851 gallons.

Is the water bill for China’s economic growth finally coming due? China’s economic growth trajectory has come at the expense of its limited water resources. The country accounts for 20% of the world’s population but holds only 7% of its freshwater reserves.

This problem has been exacerbated by China’s artificially low water prices (see page 8), which encourages over-consumption. In a recent report, Barclays estimated that about 50% of China’s industrial output and 40% of its water-intensive agriculture products are produced in 11 of its most arid regions.6

We feel that ever tighter water reserves will ultimately force China—already the world’s largest importer of food—to increase food imports even more. In 2020, these totalled $157.8 billion, up from $133.1 billion in 2019.

2 “It’s Some of America’s Richest Farmland. But What Is It Without Water?”, New York Times, October 21, 2021 3 “The Future of Water Is Recycled Sewage, And We'll All Be Drinking It,” Bloomberg, May 19, 2021 4 California Department of Water Resources, 2021 5 “Drought Imperils Economy in California’s Farm Country,” Wall Street Journal, May 21, 2021 6 “Water: The ‘True Cost’,” Barclays, June 1, 2021

100

200

300

400

500

600

700

800

900

1,000

2016 2017 2018 2019 2020 2021 2022 2023

Water prices have surgedNASDAQ Veles California Water Index (as of November 9, 2021)

Index

NBF Economics and Strategy (data via Bloomberg)

3



Source: Trade Data Monitor; USDA FAS Global Agricultural Trade System (GATS)

These demand and supply pressures have left China’s agriculture sector overly vulnerable to unexpected shocks. This has been proven by recent events, such as the African swine flu, COVID-19, floods in the south, droughts in the north, and electricity shortages.

India’s increasingly unsustainable water consumption India has even less readily available water reserves than China does. India has 16% of the world’s population but holds only 4% of its available freshwater resources.7 Agriculture alone accounts for more than 80% of its demand for water.8

While India is currently self-sufficient in most types of food production, many analysts worry this independence is built on an unstable foundation of cheap water prices, which encourages over-consumption.

Despite India’s limited supply of water, its citizens pay among the lowest water prices in the world (see page 8). This is particularly the case for farmers, who also benefit from free or heavily subsidized electricity to pump groundwater. The World Bank estimates that groundwater accounts for “about 85% of domestic water supply in rural areas, 45% in urban areas, and over 60% of irrigated agriculture.”9

Experts warn that this combination of cheap water and electricity prices could soon threaten India’s ability to produce food. UNSECO estimates that groundwater levels have already declined 61% from 2007 to 2017.10 Another study published in the journal Science Advances warned that, at the current pace, declining groundwater levels could decrease harvests 20% on average nationwide and 68% in the most severely impacted regions by as early as 2025.11

We feel that similar to China, India will ultimately have little choice but to increase water prices in order to encourage more efficient practices that include utilizing irrigation systems, switching to less water-intensive crops, and increasing food imports. More efficient water usage will become all the more crucial as demand rises the more people get connected to water networks.

Currently, only 43% of rural households in India, which account for 65% of its total population, have water connections. This is nevertheless up from only 17% in 2019.12 Growing demand for water will also necessitate an upgrade in sewage treatment capacity. According to government figures, less than half the sewage in urban areas is treated.13

7 World Bank, 2021 8 “India’s water crisis is already here. Climate change will compound it,” MIT Review, April 24, 2019 9 “Addressing groundwater depletion: Lessons from India, the world’s largest user of groundwater,” World Bank, August 23, 2021 10 “The ancient stepwells helping to curb India's water crisis,” BBC, October 12, 2021 11 “Groundwater depletion will reduce cropping intensity in India,” Science Advances, 2021, and “India's groundwater crisis threatens food security for hundreds of millions, study says,” CNN, February 24, 2021 12 “For Narendra Modi’s re-election prospects, clean water in India is liquid gold,” South China Morning Post, October 11, 2021 13 “On Delhi’s Toxic River, Prayers to a Sun Struggling to Shine Through Smog,” New York Times, November 11, 2021

4



Brazil’s drought endangers global food production Brazil is among the world’s leading food producers. It accounts for four fifths of the world’s orange-juice exports, half of its sugar exports, one third of coffee exports, and one third of the soy and corn used to feed the world’s livestock.14

Unfortunately, Brazil has recently been hit by one of the worst droughts in almost a century. In October, the country’s water reservoirs had fallen 25% below their five-year average.15 This has hurt crop yields and contributed to the global rise in the price of certain agricultural commodities. It also weakened Brazil’s ability to generate hydroelectricity, which typically covers about 65% of its power needs.

Many people wonder how a country with the world’s most freshwater resources could be experiencing a shortage. One reason, as the map below illustrates, is that much of its water is located in Amazonia, the northwestern part of the country, far away from the agriculture producing regions and major cities located in the southeast. Another reason is the lack of water-related infrastructure: 100 million of Brazil's 212 million people are presently not connected to sewage systems.16

Source: “The Country That Makes Breakfast for the World Is Plagued by Fire, Frost and Drought,” Bloomberg, September 28, 2021

Some environmentalists claim the recent drought is being exacerbated by deforestation in the Amazon, which last year surged to its highest level in more than a decade. They claim that the more rainforests are cut, the less they are able to play their crucial role of recycling vast quantities of rainwater to the atmosphere.17

14 Climate Change in Brazil: Fire, Frost, Drought Upends Global Markets,” Bloomberg, September 28, 2021 15 “What is behind soaring energy prices and what happens next?” International Energy Agency, October 12, 2021 16 “Brazil government privatizes Rio's water treatment for $4 billion,” Deutsche Welle, May 1, 2021 17 “The Amazon’s Little Tipping Points,” Reuters, October 21, 2021

5



Transitioning to green energy means a surge in mineral demand The World Bank projects that demand for minerals, such as graphite, lithium and cobalt, could increase nearly 500% by 2050 to reach net-zero emissions by 2050.18 This transition to a green economy includes a surge in demand for copper. Goldman Sachs has estimated that an electric vehicle contains five times as much copper (60–83kg) as does a car with an internal combustion engine, while a 3- megawatt wind turbine includes up to 4.7 tonnes of copper.19

In all, the typical electric car requires six times as many minerals to build as does a combustion-engine car and an onshore wind plant requires nine times as many resources to build as does a gas-fired plant.

Source: “The Role of Critical Minerals in Clean Energy Transitions,” IEA, May 2021

The water required to extract these minerals another challenge Mining is a particularly water-intensive process. Extracting lithium from South America’s Lithium Triangle—a region that covers parts of Argentina, Bolivia and Chile—involves pumping large amounts of water underground and pushing up a salty mud known as brine, which contains lithium. The brine is left in large pools until the water evaporates. After 12 to 18 months, the process is complete and lithium carbonate can be extracted and processed.20

Copper mining involves crushing copper-rich rocks to dust and mixing it with water to be transported through giant pipes. The liquid is then further mixed with chemicals to separate the copper from other mineral residue.21

The water intensity of the mining sector is further complicated by the fact that approximately 50% of today’s lithium and copper production is concentrated in areas with high water-stress levels.22

18 “Mineral Production to Soar as Demand for Clean Energy Increases,” World Bank, May 2020 19 ““Copper boom: how clean energy is driving a commodities supercycle,” Financial Times, June 7, 2021 20 “The Lithium Triangle: Where Chile, Argentina, and Bolivia Meet,” Harvard International Review, January 15, 2020 21 “Saving the Planet With Electric Cars Means Strangling This Desert,” Bloomberg, June 11, 2019 22 “The Role of Critical Minerals in Clean Energy Transitions,” Internatioanl Energy Agency, May 2021

6



Source: “The Role of Critical Minerals in Clean Energy Transitions,” IEA, May 2021

Source: “Increasing Water Risks in Metals and Mining,” Fitch Ratings, July 8, 2021

One solution being increasingly adopted to alleviate growing water stress, particularly in Chile, is desalination. It is important to note, however, that this necessary measure adds significantly to operating costs.

7



The underpricing of water Solutions do exist to tackle some of the world’s water challenges. These include recycling wastewater, desalination, and using drip irrigation in agriculture to deliver just the right amount of water to crops.

The bad news is that these fixes are expensive and must contend with the fact that water is significantly under-priced in many countries. On the demand side, this means consumers often have little incentive to conserve water. On the supply side, investors have little incentive to lay pipes and build treatment plants. Also, low prices encourage production of water-intensive products in water-scarce regions.

For example, the following charts illustrate that, despite their relatively scarce water resources, China and India have among the world’s cheapest water prices.

8



Conclusion Since importing water from overseas is not viable from an economic or logistical perspective, once a region’s water use exceeds its natural rate of replenishment, the best solution is to reduce water consumption to more sustainable levels by increasing its price and/or importing more water-intensive products from abroad. This, among other things, will force countries such as India and China to choose between focusing more on industry or on agriculture. (For the amount of water required to produce various goods please refer to our January 2020 report titled “The world’s looming water crisis.”)

Given that higher water prices could trigger significant political backlash, we can expect some countries to introduce measures to financially cushion the blow. It will be politically tempting also to impose even sharper price increases on foreign companies.

Meanwhile, the growing scarcity of water in certain farming regions of Brazil and the United States will likely lead to higher water prices to both encourage greater efficiency and pay for much needed upgrades to water-related infrastructure. Similarly, water scarcity in many of the world’s mining regions will force an increase in water-related costs.

Food prices

Higher water prices will add to the inflationary pressures already impacting the food sector, which include the rising cost of transportation, labour, energy, and fertilizers. (Brazil, for example, relies on imports for 80% of its fertilizer requirements.23)

The impact of rising food prices will be felt particularly in the developing world. Food accounts for 30% of household spending in India compared with only 10% in the United States.24

23 “For Brazil, a Bad Year Could Get Worse,” Geopolitical Futures, October 20, 2021 24 “Food prices are soaring and could deliver the next disaster to the developing world,” The Globe & Mail, May 14, 2021

84

88

92

96

100

104

108

112

116

120

124

128

132

136

2015 2016 2017 2018 2019 2020 2021 2022

World: Food prices have surgedUN World Food and Agriculture Price Index (as of November 16, 2021)

Index

NBF Economics and Strategy (data via Bloomberg)

9




Montreal Office Toronto Office 514-879-2529 416-869-8598

Stéfane Marion Matthieu Arseneau Paul-André Pinsonnault Warren Lovely Chief Economist and Strategist Deputy Chief Economist Senior Economist Chief Rates and Public Sector Strategist [email protected] [email protected] [email protected] [email protected]

Kyle Dahms Daren King Jocelyn Paquet Taylor Schleich Economist Economist Economist Rates Strategist [email protected] [email protected] [email protected] [email protected]

Alexandra Ducharme Angelo Katsoras Alpa Atha Economist Geopolitical Analyst Fixed Income Economist [email protected] [email protected] [email protected]

General

This Report was prepared by National Bank Financial, Inc. (NBF), (a Canadian investment dealer, member of IIROC), an indirect wholly owned subsidiary of National Bank of Canada. National Bank of Canada is a public company listed on the Toronto Stock Exchange.

The particulars contained herein were obtained from sources which we believe to be reliable but are not guaranteed by us and may be incomplete and may be subject to change without notice. The information is current as of the date of this document. Neither the author nor NBF assumes any obligation to update the information or advise on further developments relating to the topics or securities discussed. The opinions expressed are based upon the author(s) analysis and interpretation of these particulars and are not to be construed as a solicitation or offer to buy or sell the securities mentioned herein, and nothing in this Report constitutes a representation that any investment strategy or recommendation contained herein is suitable or appropriate to a recipient’s individual circumstances. In all cases, investors should conduct their own investigation and analysis of such information before taking or omitting to take any action in relation to securities or markets that are analyzed in this Report. The Report alone is not intended to form the basis for an investment decision, or to replace any due diligence or analytical work required by you in making an investment decision.

This Report is for distribution only under such circumstances as may be permitted by applicable law. This Report is not directed at you if NBF or any affiliate distributing this Report is prohibited or restricted by any legislation or regulation in any jurisdiction from making it available to you. You should satisfy yourself before reading it that NBF is permitted to provide this Report to you under relevant legislation and regulations.

National Bank of Canada Financial Markets is a trade name used by National Bank Financial and National Bank of Canada Financial Inc.

Canadian Residents

NBF or its affiliates may engage in any trading strategies described herein for their own account or on a discretionary basis on behalf of certain clients and as market conditions change, may amend or change investment strategy including full and complete divestment. The trading interests of NBF and its affiliates may also be contrary to any opinions expressed in this Report.

NBF or its affiliates often act as financial advisor, agent or underwriter for certain issuers mentioned herein and may receive remuneration for its services. As well NBF and its affiliates and/or their officers, directors, representatives, associates, may have a position in the securities mentioned herein and may make purchases and/or sales of these securities from time to time in the open market or otherwise. NBF and its affiliates may make a market in securities mentioned in this Report. This Report may not be independent of the proprietary interests of NBF and its affiliates.

This Report is not considered a research product under Canadian law and regulation, and consequently is not governed by Canadian rules applicable to the publication and distribution of research Reports, including relevant restrictions or disclosures required to be included in research Reports.

10



UK Residents

This Report is a marketing document. This Report has not been prepared in accordance with EU legal requirements designed to promote the independence of investment research and it is not subject to any prohibition on dealing ahead of the dissemination of investment research. In respect of the distribution of this Report to UK residents, NBF has approved the contents (including, where necessary, for the purposes of Section 21(1) of the Financial Services and Markets Act 2000). This Report is for information purposes only and does not constitute a personal recommendation, or investment, legal or tax advice. NBF and/or its parent and/or any companies within or affiliates of the National Bank of Canada group and/or any of their directors, officers and employees may have or may have had interests or long or short positions in, and may at any time make purchases and/or sales as principal or agent, or may act or may have acted as market maker in the relevant investments or related investments discussed in this Report, or may act or have acted as investment and/or commercial banker with respect hereto. The value of investments, and the income derived from them, can go down as well as up and you may not get back the amount invested. Past performance is not a guide to future performance. If an investment is denominated in a foreign currency, rates of exchange may have an adverse effect on the value of the investment. Investments which are illiquid may be difficult to sell or realise; it may also be difficult to obtain reliable information about their value or the extent of the risks to which they are exposed. Certain transactions, including those involving futures, swaps, and other derivatives, give rise to substantial risk and are not suitable for all investors. The investments contained in this Report are not available to retail customers and this Report is not for distribution to retail clients (within the meaning of the rules of the Financial Conduct Authority). Persons who are retail clients should not act or rely upon the information in this Report. This Report does not constitute or form part of any offer for sale or subscription of or solicitation of any offer to buy or subscribe for the securities described herein nor shall it or any part of it form the basis of or be relied on in connection with any contract or commitment whatsoever.

This information is only for distribution to Eligible Counterparties and Professional Clients in the United Kingdom within the meaning of the rules of the Financial Conduct Authority. NBF is authorised and regulated by the Financial Conduct Authority and has its registered office at 70 St. Mary Axe, London, EC3A 8BE.

NBF is not authorised by the Prudential Regulation Authority and the Financial Conduct Authority to accept deposits in the United Kingdom.

U.S. Residents

With respect to the distribution of this report in the United States of America, National Bank of Canada Financial Inc. (“NBCFI”) which is regulated by the Financial Industry Regulatory Authority (FINRA) and a member of the Securities Investor Protection Corporation (SIPC), an affiliate of NBF, accepts responsibility for its contents, subject to any terms set out above. To make further inquiry related to this report, or to effect any transaction, United States residents should contact their NBCFI registered representative.

This report is not a research report and is intended for Major U.S. Institutional Investors only.

This report is not subject to U.S. independence and disclosure standards applicable to research reports.

HK Residents

With respect to the distribution of this report in Hong Kong by NBC Financial Markets Asia Limited (“NBCFMA”)which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 (dealing in securities) and Type 3 (leveraged foreign exchange trading) regulated activities, the contents of this report are solely for informational purposes. It has not been approved by, reviewed by, verified by or filed with any regulator in Hong Kong. Nothing herein is a recommendation, advice, offer or solicitation to buy or sell a product or service, nor an official confirmation of any transaction. None of the products issuers, NBCFMA or its affiliates or other persons or entities named herein are obliged to notify you of changes to any information and none of the foregoing assume any loss suffered by you in reliance of such information.

The content of this report may contain information about investment products which are not authorized by SFC for offering to the public in Hong Kong and such information will only be available to, those persons who are Professional Investors (as defined in the Securities and Futures Ordinance of Hong Kong (“SFO”)). If you are in any doubt as to your status you should consult a financial adviser or contact us. This material is not meant to be marketing materials and is not intended for public distribution. Please note that neither this material nor the product referred to is authorized for sale by SFC. Please refer to product prospectus for full details.

There may be conflicts of interest relating to NBCFMA or its affiliates’ businesses. These activities and interests include potential multiple advisory, transactional and financial and other interests in securities and instruments that may be purchased or sold by NBCFMA or its affiliates, or in other investment vehicles which are managed by NBCFMA or its affiliates that may purchase or sell such securities and instruments.

No other entity within the National Bank of Canada group, including National Bank of Canada and National Bank Financial Inc, is licensed or registered with the SFC. Accordingly, such entities and their employees are not permitted and do not intend to: (i) carry on a business in any regulated activity in Hong Kong; (ii) hold themselves out as carrying on a business in any regulated activity in Hong Kong; or (iii) actively market their services to the Hong Kong public.

Copyright

This Report may not be reproduced in whole or in part, or further distributed or published or referred to in any manner whatsoever, nor may the information, opinions or conclusions contained in it be referred to without in each case the prior express written consent of NBF.

geopolitical briefing : the looming global water crisis

Documents